Alpha Trading

PERRY KAUFMAN has more than thirty years of experience in financial engineering and hedge funds, and is well-known for his role in algorithmic trading. Since 1971, he has specialized in the development of fully systematic trading programs in derivatives and equities as well as risk management and leverage overlays. He is the author of New Trading Systems and Methods, Fourth Edition, A Short Course in Technical Trading, both from Wiley, and other books and articles that have gained worldwide acclaim.

• Preface ixChapter 1 Uncertainty 1Impact on Trading 2The Inevitable Price Shocks 3Why So Much about Price Shocks? 9Complexity and Contagion Risk 10The Ugly Side 11Taking Defensive Action 11Accepting Performance for What it is 13Chapter 2 The Importance of Price Noise 15Noise Explained 15Different Markets 19A Closer Look at Equity Index Markets 21Importance of Noise 22Determining the Strategy 25Capitalizing on the Trend of Noise 29Chapter 3 Pairs Trading: Understanding the Process 31The Process 32The Basics 32Target Volatility 54Home Builders 65Using ETFs 78Portfolio of Home Builder Pairs 84Execution and the Part-Time Trader 89Stop-Losses 89Trading Intraday 90Key Points to Remember 90Chapter 4 Pairs Trading Using Futures 93Futures 94Mechanics of a Pairs Trade in Futures 97Inflation Scares 100Trading Energy Pairs 102Revisiting Momentum with Energy Markets 105A Miniportfolio of Natural Gas Pairs 112The Inflation Pairs: Crude, the EURUSD, and Gold 119Equity Index Pairs 128Leveraging with Futures 138London Metals Exchange Pairs 141Volatility Filters 153Interest Rate Futures 154Summary 154Chapter 5 Risk-Adjusted Spreads 155Dell and Hewlett-Packard 155Trading Both Long-Term (Hedged) Trends and Short-Term Mean Reversion 159Gold, Platinum, and Silver 161The Platinum/Gold Ratio 163Implied Yield 170The Yield Curve 174Trend Trading of London Metal Exchange Pairs 179Summary 184Chapter 6 Cross-Market Trading and the Stress Indicator 187The Crossover Trade 188The Stress Indicator 189Gold, Copper, and Platinum 195Mining Companies 198Agribusiness Pairs 206The Major Energy Producers 208Portfolio of Cross-Market Energy Pairs 220Other Opportunities 226Some Final Notes 228Chapter 7 Revisiting Pairs Using the Stress Indicator 229Futures Markets and the Stress Indicator 229Equity Index Futures 230Interest Rate Futures 238The Portfolio Spreadsheet 245Summary of Pairs Trading 248Chapter 8 Traditional Market-Neutral Trading 249Home Builders 250Trend or Mean Reversion? 250Basic Market-Neutral Concept 251Volatility-Adjusting the Position Size 264Arbing the Dow: A Large-Scale Program 267Thoughts about Market-Neutral Trend Following 274Market Neutral Using Futures 274Market-Neutral Comments 277Chapter 9 Other Stat-Arb Methods 281Trade-Offs 282System Briefs 282New Highs and New Lows 290Merger Arb 290Creating Your Own Index Arbitrage 292Arbing the Dow 301Arbing the S&P 500—Index Arbitrage 302About the Companion Web Site 305About the Author 306Index 307

“Whenever Perry Kaufman writes a new book . . .system traders take note. What separates Kaufman’s work from that of many other writers on trading strategies is that he goes into the nuts and bolts of designing and testing system candidates. . . The website that accompanies the book has spreadsheets that make the calculations necessary for setting up trades ever so much easier. . .  What Kaufman offers is different — essentially a do-it-yourself manual for the trader who wants to develop strategies that remove directional risk and unearth opportunities for creating alpha.” (Seeking Alpha)